When a team of former Bear Stearns credit analysts decided to set up their own event driven long/short credit hedge fund the pitch to potential investors was straightforward. Allocate with us and we will take you through the credit cycle, generating absolute returns regardless of how the market performs. That approach has seen the Brownstone Partners Catalyst Master Fund generate a net annualised return of 10.15% since inception in July 2004. During that time the fund’s assets have grown to $370 million. Now that the credit market is front and centre with investors, the fund is attracting attention, not least because it recently featured in 82nd place in Barron’s list of the 100 top performing hedge funds over the three years to end-2008.

“The key to our approach, which is very relevant at this point in the cycle, is that we developed the strategy to provide full directional flexibility through the business cycle,” says Oren M. Cohen, co-founder, portfolio manager and head of research with New York-based Brownstone Asset Management LP. “The genesis was really our belief, through our experience, that not a lot of credit managers had a flexible approach to generate returns through the credit cycle.”

Cohen is careful to emphasise that this is not a message tailored to the current environment. He, co-founder Douglas Lowey and subsequent partner Curt Schade, who joined Brownstone in 2006, all worked at Bear Stearns in the mid-1990s. During that period and later they all saw how a high yield hedge fund could provide absolute returns by combining painstaking research with the nimbleness to trade around the broader credit cycle. “When it’s time to be short, we’ll swing this portfolio short,” Cohen says. “That’s how we not only stayed out of trouble last year, but generated good positive returns in a very down market. We think that that discipline will also help us outperform in what everyone is now looking to as the big long opportunity in credit because we are disciplined to recognize the pitfalls on the downside.”

Net exposures adjusted
Each of the three principals has 20 years’ experience in high yield credit markets, enough to have ridden through several business cycles. The portfolio swung from 30% net long at the end of 2006 to 65% net short during the 2008 downturn, but is currently market-neutral and is growing its long book opportunistically. The fund is targeting surviving high yield credits on the long side – those that will avoid defaults – and is playing deeply distressed credits on both the long and short sides.